Looking through some of the predictions for Budget 2013, I see a few people mentioning the prospect of self-employed businesses being subject to an increase in National Insurance Contributions.

I understand the rationale for this being related to the introduction of the flat-rate pension. This means that the self-employed receive a greater benefit compared to their input. But I see this as a very poor idea in terms of a revenue raiser.

In terms of tax, it is almost always better to run your business through a company. Profits earned by a self-employed individual predominantly result in a higher tax charge than the those earned by a company paying them out as dividends.

[NB The dividends are normally distributed after paying out a salary that does not result in any NIC charge, but still counts as contributions for the year. So the pension entitlement is also maintained.]

Pushing up NICs on self-employed individuals will make this tax differential between self-employed and incorporated businesses harder for even the smallest businesses to ignore.

I think you’d see the potential revenue being raised severely undermined by the behavioural shift.

Now, the obvious answer to this is to introduce a corresponding increase in the tax burden on an incorporated business. This could be an increase in the rate of tax just on dividends in some way, but this starts to have further impacts elsewhere. So I can’t see this being done without more thought.

Also how does this sit with the attempt to introduce a simpler basis of taxation for smaller businesses from this April? The new simplified cash basis, fixed rate deductions and the disincorporation relief all promote the benefits of operating through an unincorporated entity.

But, let’s face it, they’re not exactly amazing reasons to not run through a company. You’d see these snubbed in favour of the cash saving option, I’ll wager.

So I’m broadly against the idea of such an increase. But, then again, the resulting rise in administration would be good for accountants…

One Response to Self-employed NICs hike? I hope not… Or do I?

The problem with the incorporation question has always been that with a company there can be much more of a separation of ownership and management than you get with unincoporated entities, and so the two different ways of looking at the operating surplus before the owner-manager gets paid are thrown into sharper relief. Is it due to him because he’s been working in the business, or because he owns the business? Shoud I come out as salary or profit?

The two are mixed for a sole trader, and I think this is why the Class 4 NI rate is lower than the Class 1: it covers the proprietor’s profit as well as his “employment” income. If you push it up to say the Class 1 level, you’re effectively taking all his income as “employment”, whereas the company owner is still free to take some as dividends.

The problem just comes from differences in treatment between employment income and proprietor’s profit, and between IT and CT (CT being essentially basic-rate IT now). To remove the issue you need to eliminate those; conversely, if you want to keep those differences you need to make sure they’re pushing things the way you want. At present I think they’re pushing people into companies to pay no more than basic rate, and HMRC wants them to be employees at higher rate, and that’s where the tension lies.

I can’t see an easy answer to this: my immediate reaction is to say you should split the two income streams more clearly and tax them as such, but then my brain points out that there’s no easy way to do this.

I think it all comes down to HMRC’s view that self-employed people are really employees who are trying to reduce their tax bill by claiming not to be: hence IR35, etc. One way to do it might therefore be to extend IR35 to say that not only should the proprietor of a service company be paid all his quasi-employment income through PAYE, but the proprietor of any company should be paid a minimum amount as salary before he takes dividends: more than the £7,500 they normally take, anyway. Perhaps an arm’s length amount (so easy to do!), or a flat rate, or a proportion? I can’t see a simple and fair way to do it, if the regime is to cover everything from the local shop to ICI. Perhaps it could only apply to close companies though?

The other way would be to eliminate the differences and treat all businesses as subject to corporation tax. Deem them to be companies, effectively, with drawings treated as dividends and no employment income at all in there. Class 2/4 NI would disappear, so you’d have to take your £7,500 drawings to get a Class 1 stamp. A whole other can of worms 🙂